Chapter 6

4 Golden Rules
Successful DayTraders Follow these Rules on Every Trade
Rule 1: Always know your exit points on both sides of the trade (profit AND loss) before you enter (or very soon after you have been filled)…. One of the biggest mistakes a trader can make is to enter a trade blindly without knowing what kind of profit they are looking for; or what amount of loss they can tolerate. Often times, it is not enough to designate a percentage of profit when entering and closing a trade intra-day. What an intuitive trader must do is set a percentage of the average range a certain security usually trades in and stick to it. In other words, if the average daily fluctuation for an option or stock is 1 ½ points, you might consider taking profits at 30% of the range – approximately 7/16 in our example, for each individual trade When I first began trading, I tended to think in terms of getting a whole point out of every trade. However, the average range of that particular option or stock may have only been ¾ to one point. Even if I had timed it perfectly and bought at the low of the day and sold at the high of the day, I would have only achieved ¾ of a point. On highly volatile stocks (one that fluctuates 4-6 points in an average day such as ASMLF), one point was far to small to allow on the downside. I would find myself getting “stopped out” at one point because a one point move in such a volatile stock amounted to only 3 or 4 ticks. I found that if I placed my stops just ½ point further out, I could remain in the game and wait for the move to the upside. Of course, 1 ½ points translates to $1500 if you are trading 1000 shares or 10 option contracts. This may be too rich for your risk tolerance. If so, stick with those stocks and options which have a smaller intra-day range. Less profit potential? Yes, but less chance of a catastrophic loss. So how do you find a stock’s average range? Most quote web sites will give the previous day’s range but that may not always be enough. Unless you are attempting to make a play on a breaking news story, you should avoid trading in stocks you have never watched in the past. Successful traders tend to find a group of 10-15 issues they watch each and every day; so much so that they begin to be able to predict the movements of each stock and know what kind of fluctuation to expect on an average day. Rule 2: Always check the intra-day tick by tick chart before placing an order. Buying at the high of the day on no news is a sure fire way to take an immediate loss. Just as stocks will move in trends on a daily chart, they move similarly intra-day on a tick by tick basis. Your real time quote service should include tick by tick charts. These charts, as they develop in front of you, are an invaluable tool you can use to anticipate the current trend in the stock and assist you in seeing where your order will fall in relation to where the prices have been earlier in the trading session. Additionally, although the stock may have upticked several times indicating that it may be on the rise, a quick look at the intra-day chart may reveal that the price has been heading down for the previous thirty minutes. It would be advantageous to know suchthings prior to getting filled! Big moves up are sometimes followed by big moves down and visa versa. Sell on abnormally large moves to the upside and buy on abnormally moves to the down side. They are generally out of character of the stock and can many times be followed by a "snap back" on the stock. Knowing your stock's trading habits can be very helpful. Be very careful buying stocks that have just made sudden moves up. Many times they are followed very soon after by sudden profit taking. Rule 3: Always stick to your stops! Every trader you ever speak with will have a story about how two weeks of diligently earned profits were wiped out in one losing trade because they waited to long to get out. It is painfully easy to say, “Damn, I hit my mental

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 DayTradersUSA Jan 2001

2/15/2001

stop – maybe I’ll just wait a few more ticks to see if it turns around.” Don’t fall into this common trap. If you identify your exit points before you enter your trades, you’ll save yourself from yourself. The stock market is very good at playing on your emotions. In order to be a good trader, you must look at the market in a cold, hard way. When the masses are selling in a panic, you must stand fast or step up and buy. Remember that the market is made up of emotional sheep buying and selling in waves - you must be the cold, cunning and calculating wolf looking over the heard for your kill. Don't panic sell and don't buy on hysteria. Executing a mental stop forces us to admit that we were wrong in the first place. For entrepreneurial types, this is extremely difficult. We all want to be right on every trade; cutting your losses quickly will ensure you are still in the game two years from now. Rule 4: Always trade WITH the trend “Time and Sales” can be another invaluable tool for traders when determining the trend of the market. If you are just beginning and do not have NASDAQ Level II quotes, you can often get a feel for the current trend by watching how many orders come across at the bid and how many at the ask. A danger sign should flash in your eyes when you see numerous orders coming in to buy at the ask with no movement in the stock price to the upside. It will normally be accompanied with a downtick with even a small sell order. This is particularly true in options. Many an option trader has been frustrated by what appears to be strong buying in the option with no movement in the stock. Consistent buying should normally be accompanied with increasing share prices. If it is not, perhaps other information is in play and it might be best to stay away – the trend may be different than you anticipate! If I had one tool to use while trading it would be an intra-day chart. After determining that you are not buying at the high of the day, verify that your position is in line with the current trend. Just as a daily chart may show a stock has been “channeling” in a certain price range, intra-day charts have their own channels. A stock or option may show five or six up ticks in a row, but a quick analysis of the intra-day chart may reveal that the stock has been steadily weakening all day in a consistent channel. Although it may be nearly impossible to catch a top or bottom, an intraday chart will at least give you a clearer picture of where the price is going. Finally… That’s the heart of it all! There is no question, that if you are disciplined enough to follow a plan such as the one just outlined, it will dramatically improve your results many times over. But the fact is, most individuals will never even make it past Rule #1. Why? If I had to choose the biggest difference between winners and losers it would be knowing what to expect from your choices. Winners cut their losses short and move on to the next winning trade. Losers hold on to falling stocks ¼ point by ¼ point until the very ability to make a rational decision has been zapped from their bodies. This fatal error is as much as an ego problem as anything because the trader is forced to admit that they were wrong before selling out. DO NOT fall into the trap of buying more of the loser stock because you think that it’s now cheaper than the original purchase price. When I first started out in this business, I was extremely inconsistent. I broke every rule discussed in this manual. The day I bought a stock was the last up day that issue would see in a great while. When I sold, it was sure to be at the bottom just before a major multi-point move. Every trader encounters losses, but if you are disciplined you can forgo the account destroying ones and slowly build your account and obtain the lifestyle you dream of now.

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 DayTradersUSA Jan 2001

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